With Expectations So Low, Economy Starts to Look Good

After months of disappointing financial markets, U.S. economic data may actually start to look better than Wall Street expects.

The first glimpse of that may be showing up in Citigroup’s economic surprise index, which has started to turn up and is watched by analysts as a sign of possible market turns.

The widely followed metric, put together by the FX Quantitative Research group at Citigroup , tracks data versus economists’ expectations.

With 1.5 percent gross domestic product(explain this) growth last quarter, it’s hard to say there are any rosy forecasts out there, but economists may have become so grim that they now could be too negative.

“It’s been coincident with turning points, certainly over the last two summers,” said Andrew Burkly, equity strategist with Brown Brothers Harriman.

“It led the downturn certainly last spring and this spring. It’s just an expectations thing,” he said. “What’s driven the market is the growth acceleration, growth deceleration. That kind of ebb and flow is followed by that measure.”

Burkly said he is cautious on the market and does not trust the recent rally, which has been led by defensives. But he sees the Citi index as one bright spot.

“It’s still below zero, which tells you they’re still missing, but missing to a lesser degree,” Burkly said. He also said the index dropped a bit early in February, but still it goes in the right direction.

“Over the last two months, you’ve seen so many economists taking their numbers down, that the data started to surprise,” he said.

Burkly said he believes stocks are being held aloft by the expectation of more stimulus (explain this) from the Federal Reserve (explain this), which ironically is dependent on data weakening, not improving.

Just on Tuesday, there was a batch of economic reports that beat economists’ views.

Consumer confidence and the Chicago purchasing management index were both better than expected. Consumer confidence, in fact, increased for the first time in five months, rising to 65.9 form 62.7 in June.

The Chicago PMI was 53.7 in July, compared to forecasts for 52.5 and a reading of 52.9 in June. But spending data was weaker than expected, showing a cautious consumer even as their incomes grew at the fastest pace in three months.

S&P Case-Shiller home price data was also a little stronger than expected, in keeping with many of the housing reports of the last two months. Housing, painfully slow to recover, has been showing signs of turning.

Citigroup economist Steven Wieting said the economy should be getting cleaner readings in the second half of the year, after the seasonal factors that impacted the first half, especially jobs.

Wieting expects the economy to grow at 1.75 percent in the third quarter and 2 percent in the fourth quarter.

“It’s been a very modest recovery, and nothing’s changing in that immediately. There are a lot of challenges ahead of us. The fiscal cliff is the big domestic issue,” he said. The so-called fiscal cliff is the Dec. 31 expiration of Bush-era tax breaks combined with automatic spending cuts, Congress agreed to as part of the debt ceiling deal.

As for the Citi surprise index, Wieting notes the index was negative in the spring and summer of the past three years.

“It was markedly positive fall and winter for the past three years," he said. "Where you have seen surprises is in employment data and business and consumer confidence.”

“Our winters have been for the bulls, and our summers have been for the bears, and the winter’s up next,” he said.

He said he is forecasting that 140,000 jobs were created in July, well above the consensus 100,000. He said the job creation in the first quarter, which averaged 225,000, was impacted by seasonal factors, and the more sluggish growth of the last three months was also impacted by seasonals.

“You should get something closer to the average for the first two quarters” for July non-farm payrolls, he said.

The jobs report is expected Friday, and it is being widely watched as a potential trigger for Fed easing. Meanwhile, the Fed began a two-day meeting Tuesday. Many economists expect the Fed to delay any significant new easing until at least September so it can review incoming data.

“It’s plausible that the components of the surprise index are going to look better, now that everybody is convinced employment is terrible,” Wieting said.

“You can see how these exaggerations could play out in a positive way for expectations,” he said.